McKinsey’s Three Horizons Framework

Mehrdad Baghai, Stephen Coley and David White in their book “The Alchemy of Growth”  define the three horizons for growth. The book was based on a study of 40 growth companies, where the authors tried to identify how these successful companies approach and implement growth strategies. The key pattern that the authors identified is one of a step-by-step approach, a “staircase of initiatives.” Companies certainly keep an eye on the longer term strategy, but also simultaneously manage the near term. Each time a short term target is reached, a new capability is developed, a small acquisition is integrated, successful growers look at this as a platform for the next step. This may be a platform to continue to execute towards a strategic goal that had been set in the past. But it may also be a stage where new opportunities arise, that the company may not have been aware of before.

The three horizons provide a framework to think about growth in a way that balances the competing demands of focusing on the present whilst investing for the future.  The three horizons framework suggests that every organisation should think of itself as comprising three types of business or activity, defined by their ‘horizons’ in terms of years.  This can be a helpful diagnostic tool as well as an outline for a strategic plan.

  1. Horizon One (H1)  includes the core products and markets which provide the majority of your product line’s current revenue.   There, the focus is on extending and defending the business through a variety of means including enhancing the product, creating new models and versions, and penetrating the market further through greater distribution, promotion, and market segmentation.   This horizon is all about execution of the business plan.   Key metrics used are profit margin, market share and/or revenue.
  2. Horizon Two (H2)  covers products that are relatively new and emerging in the product line, or existing products newly aimed at an unfamiliar market.   They often have higher growth rates than older products in the line and may someday become a substantial source of product line revenue.   Here, the strategies involve placing large investments now in sales/distribution, marketing and product development so that they are positioned to achieve substantial profits later.   Typical metrics include profits, Compound Annual Growth Rate, and/or share of market segment.
  3. Horizon Three (H3)  contains potential new product opportunities that could generate profit and growth in the longer-term future.   The current forms of these opportunities could be anything from early ideas, to R&D projects, to pilot programs with customers. Strategies in this horizon include developing and communicating a vision — usually built upon new technology innovation — and demonstrating a compelling value proposition for the product.   Key metrics of success could include one or two successful projects with early adopter customers and citation by industry analysts.

These horizones are often represented in a graph with time on the x axis and value or fit with the environment on the y axis.

McKinsey Three Horizons Framework

As your business grows you will need to extend and defend your core business from competitors. However as more competitors enter the market you will need to look for alternate business opportunities. Finally you need to establish an environment where ideas are nurtured for future business development. The horizons are repeated over time as your future business options become core businesses.

The stage of your business will impact on your ability to achieve your desired outcome. For  example you may wish to create a large research and development section in your company to generate new ideas for the future, however the current position is at horizon one, focused on operation improvements to the core business. It will take significant resources and time to  develop an environment that will foster research and development within your company. Therefore your innovation strategy should take into account what phase of growth you are in  and where you are heading.

In essence the three horizons framework proposes that we think about business timing in terms of:

  • A short horizon where the concern is about profit and cash — it’s all about creating operational efficiency, current customer satisfaction etc.
  • A medium term horizon about a committed effort to grow a new business, work stream or client relationship. The emphasis is on the top line. In time, this business should become established, repay investment, and then take its place as a new short-horizon activity.
  • A longer term where you develop options, exploring possible future growth activities, and sort out the great ideas from the merely good ones with pilot projects and experiments.

The basic point about the three horizons framework is that managers need to avoid focusing on the short-term issues of their existing activities. Strategy involves pushing out Horizon 1 as far as possible, at the same time as looking to Horizons 2 and 3.

“The three horizons can be used to promote growth in three ways. First, as a diagnostic tool, the three horizons can help managers assess the prospects for growth at any level in an organization and reveal possible gaps in the volume and consistency of new profit sources. Second, as a language, the three horizons approach offers a coherent way to communicate with employees and investors. Its simple terminology makes it easier for both groups to understand and discuss corporate priorities…………..An excessive focus on growth can be just as much a problem as because they have failed to fill their business creation pipeline. others lose the right to grow when they become obsessed with new businesses. The novelty of these opportunities can be so exciting that managers take their eyes off horizon 1, forgetting that it must be maintained in order to provide the financial capacity to drive growth………….Another troublesome pattern occurs when companies have strong horizon 1 businesses and lots of ideas in horizon 3, but few people working to turn these ideas into real businesses. No matter how exciting the ideas may be, horizon 2 will remain empty until businesses are built. A company can find itself in an insidious situation as promising horizon 3 options lull it into a false sense of security. To complicate matters, these options can also inflate market expectations for growth far beyond the company’s capacity to meet them. As the gap between market expectations and the company’s actual growth widens, a steep fall in stock price becomes more likely.”  Alchemy of Growth – Mehrdad Baghai, Stephen Coley and David White.

Though  three horizons framework  is a good framework it really does not address the core capability question for the company. It does not force the business leaders to think outside the box in terms of potential future opportunities which are not on companies radar.

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